Yellen speech and the USD


Chair Yellen is likely to today reinforce the FOMC’s increasingly concrete message that it is ready to raise rates in December. The bar is now set, markets are now more or less expecting it. The key question is: can anything knock it off track? Markets hate surprises, and the FOMC is well aware of this. For that reason, we’ve long highlighted that the Fed funds implied probability of a rate hike is, in itself, a key determinant of whether the FOMC will hike rates. From recent commentary and this week’s minutes, we know that the FOMC seems fairly content with hiking rates this year. So with the probability of a December hike at 66%, the FOMC will be keen to keep expectations elevated to ensure that there are no surprises. Partly for this reason, we think that in her speech today, Chair Yellen will tow the fairly hawkish line that other speakers have recently adopted.
Now that markets are fairly clear about the FOMC’s intentions, we think that there is limited potential for any additional hawkish commentary to substantially boost expectations any further. In fact, barring any unexpected dovish comments, it seems that market pricing will now entirely depend on factors largely outside of the Fed’s control.

The risks include the US Presidential election, European politics and the potential for a sell-off in some risk assets towards the end of the year as investors lock-in profits. There are also two more jobs reports to contend with; the FOMC is comfortable with lower overall employment growth, but a repeat of May’s disappointing 38k initial non-farm payrolls estimate could prompt an already-cautious Fed to delay. The bottom line is that it could be tricky for market expectations to stay at or above their current 66% level right through until December’s meeting, even if in the end the Fed does decide to hike. There are still 62 days to go and many factors that could knock the Fed off course. For now, we formally maintain our 1Q17 rate hike call, but this will be kept under review depending on how these risks unfold over coming weeks.